Anatomy of a Meltdown
This section is devoted to studying the financial crisis in the USA 'Anatomy of a Meltdown' Part 1 ( Abridged version), by John Cassidy December 1, 2008 Ben Bernanke and the financial crisis. Bernanke says that he was “mistaken early on in saying that the subprime crisis would be contained.” Some are born radical. Some are made radical. And some have radicalism thrust upon them. That is the way with Ben Bernanke, as he struggles to rescue the American financial system from collapse. Early every morning, weekends included, Bernanke arrives at the headquarters of the Federal Reserve, an austere white marble pile on Constitution Avenue in Foggy Bottom. The office occupied by Bernanke, a soft-spoken fifty-four-year-old former professor, has high ceilings, several shelves of economics textbooks, and, on the desk, a black Bloomberg terminal. At Princeton, where Bernanke taught economics for many years, he was known for his retiring manner and his statistics-laden research on the Great Depression. For more than a year after he was appointed by President George W. Bush to chair the Fed, in February, 2006, he faithfully upheld the policies of his immediate predecessor, the charismatic free-market conservative Alan Greenspan, and he adhered to the central bank’s formal mandates: controlling inflation and maintaining employment. But since the market for subprime mortgages collapsed, in the summer of 2007, the growing financial crisis has forced Bernanke to intervene on Wall Street in ways never before contemplated by the Fed. He has slashed interest rates, established new lending programs, extended hundreds of billions of dollars to troubled financial firms, bought debt issued by industrial corporations such as General Electric, and even taken distressed mortgage assets onto the Fed’s books. These moves hardly amount to a Marxist revolution, but, in the eyes of many economists, including supporters and opponents of the measures, they represent a watershed in American economic and political history. Ben Bernanke, who seemed to have been selected as much for his predictability as for his economic expertise, is now engaged in the boldest use of the Fed’s authority since its inception, in 1913. Bernanke, working closely with Henry (Hank) Paulson, the Treasury Secretary, a voluble former investment banker, was determined to keep the financial sector operating long enough so that it could repair itself—a policy that he and his Fed colleagues referred to as the “finger-in-the-dike” strategy. He believed that the strategy was working. The credit markets remained open; the economy was still expanding. By mid-September, however, the outlook was much grimmer. On Monday, September 15th, Lehman Brothers, another Wall Street investment bank that had made bad bets on subprime mortgage securities, filed for bankruptcy protection, after Bernanke, Paulson, and the bank’s senior executives failed to find a way to save it or to sell it to a healthier firm. During the next forty-eight hours, the Dow Jones Industrial Average fell nearly four hundred points; Bank of America announced its purchase of Merrill Lynch; and American International Group, the country’s biggest insurance company, began talks with the New York Fed about a possible rescue. Goldman Sachs and Morgan Stanley, the two wealthiest investment banks on Wall Street, were also in trouble. The Fed talked with Wall Street executives about creating a “lifeline” for Goldman Sachs and Morgan Stanley, which would have given the firms greater access to central-bank funds. But Bernanke decided that even more drastic action was needed. On Wednesday, September 17th, a day after the Fed agreed to inject eighty-five billion dollars of taxpayers’ money into A.I.G., Bernanke asked Paulson to accompany him to Capitol Hill and make the case for a congressional bailout of the entire banking industry Paulson agreed. A bailout ran counter to the Bush Administration’s free-market principles and to his own belief that reckless behavior should not be rewarded, but he had worked on Wall Street for thirty-two years, most recently as the C.E.O. of Goldman Sachs, and had never seen a financial crisis of this magnitude. The most serious charge against Bernanke and Paulson is that their response to the crisis has been ad hoc and contradictory: they rescued Bear Stearns but allowed Lehman Brothers to fail; for months, they dismissed the danger from the subprime crisis and then suddenly announced that it was grave enough to justify a huge bailout; they said they needed seven hundred billion dollars to buy up distressed mortgage securities and then, in October, used the money to purchase stock in banks instead. Bernanke and Paulson’s reversals have been deeply unsettling, perhaps especially so for the millions of Americans who have lost jobs or defaulted on mortgages so far this year. And yet, for the past year and a half, the government has confronted a financial debacle of unprecedented size and complexity. Six and a half years ago, Bernanke was a little-known professor living in Montgomery Township, a hamlet near Princeton. As Fed chairman, Bernanke inherited an unprecedented housing bubble and an unsustainable borrowing spree. The collapse of these phenomena occurred with astonishing speed and violence. The only precursor for the current financial crisis is the Great Depression, but even that isn’t a very good comparison. In the nineteen-thirties, the financial system was much less sophisticated and interconnected. In dealing with problems affecting arcane new financial products, including “collateralized debt obligations,” “credit default swaps,” and “tri-party repos,” Bernanke and his colleagues have had to become expert in market transactions of baffling intricacy. Bernanke grew up in Dillon, South Carolina, an agricultural town just across the state line from North Carolina, where, in 1941, his paternal grandfather, Jonas Bernanke, a Jewish immigrant from Austria, founded the Jay Bee Drugstore, subsequently operated by Ben’s father and an uncle. The eldest of three siblings, Bernanke learned to read in kindergarten and skipped first grade. When he was eleven, he won the state spelling championship. In high school, Bernanke taught himself calculus, submitted eleven entries to a state poetry contest, and played alto saxophone in the marching band. During his junior year, he scored 1590 out of 1600 on his S.A.T.s—the highest score in South Carolina that year—and the state awarded him a trip to Europe. In the fall of 1971, he entered Harvard, where he wrote a prize-winning senior thesis on the economic effects of U.S. energy policy. After graduating, he enrolled at M.I.T., whose Ph.D. program in economics was rated the best in the country. His doctoral thesis was a dense mathematical treatise on the causes of economic fluctuations. He accepted a job at the Stanford Graduate School of Business, where Anna Friedmann, a Wellesley senior whom Bernanke married the weekend after she graduated, had been admitted into the master’s program in Spanish. The couple lived in Northern California for six years, until Princeton awarded Bernanke, then just thirty-one, a tenured position. Settling in Montgomery Township, they brought up two children. In 1996, Bernanke became chairman of the Princeton economics department, a job many professors regard as a dull administrative diversion from their real work. Bernanke, however, embraced the chairmanship, staying on for two three-year terms. Under his stewardship, the department launched new programs and hired leading scholars, among them Paul Krugman, whom Bernanke wooed personally. The other event that changed Bernanke’s career occurred in the summer of 1999, at the height of the Internet stock boom, when he and Gertler were invited to present a paper at an annual policy conference organized by the Federal Reserve Bank of Kansas City. The topic of the conference—which takes place at a resort in Jackson Hole, Wyoming—was New Challenges for Monetary Policy. Then, as now, there was vigorous debate among economists about whether central banks should raise interest rates to counter speculative bubbles Bernanke and Gertler argued that the Fed should ignore bubbles and stick to its traditional policy of controlling inflation. If a bubble inflated and burst of its own accord, they said, the Fed could always bring down rates to alleviate damage to the broader economy. To support their case, they presented a series of computer simulations, which appeared to show that a policy of targeting inflation stabilized the economy more effectively than one that targeted bubbles. The presentation got a mixed reception. Henry Kaufman, a well-known Wall Street economist, said that it would be irresponsible for the Fed to ignore rampant speculation. Rudi Dornbusch, an M.I.T. professor (who has since died), pointed out that Bernanke and Gertler had overlooked the possibility that credit could dry up after a bubble burst, and that such a development could have serious effects on the economy. But Greenspan was more supportive. “He didn’t say anything during the session,” Gertler recalled. “But after it was over he walked by and said, as quietly as he could, ‘You know, I agree with you.’ That had us in seventh heaven.” In December, 1996, Greenspan had warned that investors could fall victim to “irrational exuberance.” Subsequently, though, he had adopted a policy of benign neglect toward the stock market, ignoring warnings that a bubble in technology and Internet stocks had developed. The paper by Bernanke and Gertler provided theoretical support for Greenspan’s stance, and it received a good deal of publicity. In 2002, when the Bush Administration was looking to fill two vacant governorships at the Fed—there are seven in all—Glenn Hubbard, who is the dean of Columbia Business School and who was then the chairman of the White House Council of Economic Advisers, proposed Bernanke. “We needed a strong economist who understood the financial markets, and Ben had expertise in that area,” Hubbard recalled. “He is also an extremely nice person. In terms of getting on with people, he is very affable, and I thought that would help him, too.” LEXIS: Anatomy of a Meltdown WORD STUDY Explore the article and do the following tasks: 1) Match the words having similar meanings: '' 2) Match the words to produce the proper collocations:'' 3) Provide in-depth, thoughtful answers to the following questions: 1 What first steps as Chair did Ben Bernanke take? 2 What was the situation like in September 2007? 3 What drastic actions did Bernanke take while the crisis was unfolding to prevent it? 4 What was the economic situation like when Bernanke took office? 5 What were Bernanke`s achievements in adolescence? What are important facts from his biography? 6 Why do actions taken by Bernanke to head off/avert the crisis represent a watershed in American economic and political history? 7 Comment on the phrase, “…Bernanke is now engaged in the boldest use of the Fed`s authority since its inception, in 1913.” 8 What are the charges against Bernanke & Paulson`s actions to alleviate the critical situation? 9 What were the events that changed Bernanke`s career? Anatomy of a Meltdown Part 2 When Bernanke joined the Fed, it was struggling to revive the economy after the Nasdaq collapse of 2000-01 and the terrorist attacks of September 11, 2001. Between September, 2001, and June, 2003, Greenspan and his colleagues cut the federal funds rate—the key interest rate under the Fed’s control—from 3.5 per cent to one per cent, its lowest level since the nineteen-fifties. Cutting interest rates during an economic downturn is standard policy at the Fed; lower borrowing costs encourage households and businesses to spend more. But Greenspan’s rate reductions were unusual in both their scale and their longevity. With cheap financing readily available, a housing boom developed. Families bought homes they couldn’t have afforded at higher interest rates; speculators bought properties to flip; people with modest incomes or poor credit took out mortgages designed for marginal buyers, such as subprime loans, interest-only loans, and “Alt-A” loans. On Wall Street, a huge market evolved in subprime mortgage bonds—securities backed by payment streams from dozens or hundreds of individual subprime mortgages. As house prices soared, many Americans took out home-equity loans to finance their spending. The personal savings rate dipped below zero, and the trade deficit, which the United States financed by borrowing heavily from abroad, expanded greatly. Some experts warned that the economy was on an unsustainable course; Bernanke disagreed. In a much discussed speech in March, 2005, he argued that the main source of imbalance in the global economy was not excess spending at home but, rather, excess saving in China and other developing countries, where consumption was artificially low. Lax American policy was helping to mop up a “global savings glut.” “Bernanke provided the intellectual justification for the Fed’s hands-off approach to asset bubbles,” Stephen S. Roach, the chairman of Morgan Stanley Asia, who was among the economists urging the Fed to adjust its policy, told me. “He also played a key role in the development of the ‘global savings glut’ theory, which the Fed used as a very convenient excuse to say we are doing the world a big favor in maintaining demand. In retrospect, we didn’t have a global savings glut—we had an American consumption glut. In both of those cases, Bernanke was complicit in massive policy blunders on the part of the Fed.” Between 2004 and 2007, White and his colleagues continued to warn about the global credit boom, but they were largely ignored in the United States. “In the field of economics, American academics have such a large reputation that they sweep all before them,” White said. “If you add to that the personal reputation of the Maestro”—Greenspan—“it was very difficult for anybody else to come in and say there are problems building.” After years of theorizing about the economy, Bernanke revelled in the opportunity to participate in policy decisions, though he rarely challenged Greenspan. From the moment Bernanke went to work for Bush, he was seen as a likely successor to Greenspan, who was due to retire in January, 2006. On October 24, 2005, President Bush nominated Bernanke as the fourteenth chairman of the Fed, saying, “He commands deep respect in the global financial community.” After thanking the President, Bernanke said that if the Senate confirmed him his first priority would be “to maintain continuity with the policies and policy strategies established during the Greenspan years.” For more than a year, Bernanke kept his word. In the first half of 2006, the F.O.M.C. raised the federal funds rate in three quarter-point increments, to 5.25 per cent, and kept it there for the rest of the year. But cheap money was only part of Greenspan’s legacy. He had also championed financial deregulation, resisting calls for tighter government oversight of burgeoning financial products, such as over-the-counter derivatives, and applauded the growth of subprime mortgages. Bernanke hadn’t said much about regulation before being nominated as the Fed chairman. Once in office, he generally adhered to Greenspan’s laissez-faire approach. In May, 2006, he rejected calls for direct regulation of hedge funds, saying that such a move would “stifle innovation.” The following month, in a speech on bank supervision, he expressed support for allowing banks, rather than government officials, to determine how much risk they could take on, using complicated mathematical models of their own devising—a policy that had been in place for a number of years. It is now evident that self-regulation failed. By extending mortgages to unqualified lenders and accumulating large inventories of subprime securities, banks and other financial institutions took on enormous risks, often without realizing it. Their mathematical models failed to alert them to potential perils. Bernanke was more concerned about inflation and unemployment, the Fed’s traditional areas of focus, than he was about the growth of mortgage securities. “The U.S. economy appears to be making a transition from the rapid rate of expansion experienced over the preceding years to a more sustainable, average pace of growth,” he told the Senate banking committee in February, 2007. By then, home prices in many parts of the country had begun to drop. At least two prominent economists—Nouriel Roubini, at N.Y.U., and Joseph Stiglitz, at Columbia—had warned that a nationwide housing slump could trigger a recession, but Bernanke and his colleagues thought this was unlikely. On February 28, 2007, Bernanke told the House budget committee that he didn’t consider the housing downturn “as being a broad financial concern or a major factor in assessing the state of the economy.” He maintained an upbeat tone over the next several months, during which two large subprime lenders, New Century Financial Corp. and American Home Mortgage, filed for bankruptcy, and the damage spread to Wall Street firms that had invested in subprime securities. On August 9, 2007, the crisis escalated significantly after BNP Paribas, a major French bank, temporarily suspended withdrawals from three of its investment funds that had holdings of subprime securities, citing a “complete evaporation of liquidity in certain market segments of the U.S. securitization market.” In other words, trading in the mortgage securities market had ceased, leaving many financial institutions short of cash and saddled with assets that they couldn’t sell at any price. Stocks fell sharply on both sides of the Atlantic, and the following day Bernanke held a conference call with members of the F.O.M.C., during which they discussed reducing the interest rate at which the Fed lends to commercial banks—the “discount rate.” Since the Fed was founded, it has had a “discount window,” from which commercial banks may borrow as needed. The Fed decided to keep the discount rate at 6.25 per cent but issued a statement reminding banks that the discount window was open if they needed money. Seven days later, however, after more wild swings in the markets, the Fed voted to cut the discount rate by half a point, to 5.75 per cent. Bernanke now realized that the subprime crisis posed a grave threat to some of the country’s biggest financial institutions and that Greenspan-era policies were insufficient to contain it. In the third week of August, he made his second visit as head of the Fed to Jackson Hole, where he invited some of his senior colleagues to join him in a brainstorming session. “What’s going on and what do we need to do?” he asked. “What tools have we got and what tools do we need?” The participants included Don Kohn; Kevin Warsh; Brian Madigan, the head of monetary affairs at the Fed; Tim Geithner, the head of the New York Fed; and Bill Dudley, who runs the markets desk at the New York Fed. The men agreed that the financial system was facing what is known as a “liquidity crisis.” Banks, fearful of lending money to financial institutions that might turn out to be in trouble, were starting to hoard their capital. If this situation persisted, businesses and consumers might be unable to obtain the loans they needed in order to spend money and keep the economy afloat. Bernanke and his colleagues settled on a two-part approach to the crisis. (Geithner later dubbed it “the Bernanke doctrine.”) First, to prevent the economy from stalling, the Fed would lower the federal funds rate modestly—by half a point in September and by a quarter point in October, to 4.5 per cent. This was standard Fed policy—trimming rates to head off an economic decline—but it didn’t directly address the crisis of confidence afflicting the financial system. WORD STUDY Explore the article and do the following tasks: 1) Match the words having similar meanings: '' 2) Match the words to produce the proper collocations:'' 3) Provide in-depth, thoughtful answers to the following questions: 1 What was the economic situation like when Bernanke joined the Fed? 2 What was the main source of imbalance in the economy according to B.Bernanke? 3 What policy did Bernanke pursue to keep the economy afloat? 4 What blunders did Bernanke commit according to the experts dissented from the Greenspan-Bernanke line? 5 Did Bernanke keep his word to maintain continuity with the policies established during the Greenspan years? 6 What were the key focuses and results of financial policy pursued by Bernanke`s predecessor Alan Greenspan? 7 Why did self-regulation fail? 8 What was Bernanke`s attitude towards the housing downturn in 2007? Did he realize then the scale of this problem? Why?/Why not? 9 What is “liquidity crisis” characterized by and what are its repercussions? 'Anatomy of a meltdown' Part 3 ''' Abridged''' Although many people at the Fed worked on the details of the lending programs, Bernanke provided the impetus for their development. One of his first acts on taking office was to establish a financial-stability working group, which brought together economists, finance specialists, bank supervisors, and lawyers from different departments at the Fed to devise solutions to potential problems. As the subprime crisis unfolded, Bernanke met with the task force frequently to discuss the Fed’s response, including how, in seeking to expand the scope of its activities, it could exploit obscure laws from the nineteen-thirties. Despite the rate cuts and lending programs, months passed without discernible improvements in the credit markets. During the summer and fall of 2007, the drop in house prices accelerated and the number of subprime delinquencies increased. In October, at a meeting in Washington of central bankers, executives, and economists, Allen Sinai, the chief economist at Decision Economics, Inc., asked Bernanke how he thought a central bank should manage the economic risks posed by a housing bubble. According to Sinai, Bernanke said that he had no way of knowing if there had been a housing bubble. “I realized then that he just didn’t realize the scale of the problem,” Sinai told me. By the end of 2007, however, Bernanke was beginning to agree with some of the Fed’s critics that interest rates needed to come down quickly. On January 4, 2008, the Labor Department reported that the unemployment rate had jumped from 4.7 per cent to five per cent, prompting a number of economists to say that the United States was on the brink of a recession. More banks and investment banks, including Citigroup, UBS, and Morgan Stanley, were reporting big losses. Bernanke was frustrated by the attacks on his policies, especially when they came from academics whose work he respected. If he moved slowly, people on Wall Street accused him of timidity. If he brought rates down sharply, academic economists accused him of going soft on inflation. As the financial crisis worsened, Bernanke worked more closely with Paulson, who, after becoming Treasury Secretary, in June, 2006, had established considerable autonomy in determining the Bush Administration’s economic policy. The men appeared to have little in common. Bernanke was scholarly and reserved; Paulson was gregarious. Both, however, were political moderates who liked baseball. In early March, 2008, stock in Bear Stearns, the investment bank and a major underwriter of subprime securities, fell steeply amid rumors that the firm was having trouble raising money in the overnight markets, on which, like all Wall Street firms, it depended to finance its huge trading positions. Many of the bank’s clients began to withdraw their money, and many of its creditors demanded more collateral for their loans. In accommodating these requests, Bear was forced to draw on its cash reserves. By the afternoon of Thursday, March 13th, it reportedly had just two billion dollars left, not nearly enough to meet its obligations on Friday morning. The Bernanke doctrine hadn’t been designed to deal with such a situation. When Bernanke and Tim Geithner, the Fed’s point man on Wall Street, first learned of Bear’s predicament, they believed that the bank should be allowed to fail. For decades, the Fed had resisted lending to Wall Street firms for fear that it would encourage them to take excessive risks—a concern that economists refer to as “moral hazard.” (The discount window is confined to commercial banks.) Bear wasn’t one of Wall Street’s biggest firms, and its demise seemed unlikely to lead to other failures. By late Thursday night, after officials from the New York Fed and the S.E.C. visited Bear’s offices to review its books, the assessment had changed. The company was a major participant in the “repurchase”—or “repo”—market, a little publicized but vitally important market in which banks raise cash on a short-term basis from mutual funds, hedge funds, insurance companies, and central banks. Every night, about $2.5 trillion turns over in the repo market. Bear was also a big dealer in credit-default swaps (C.D.S.s), which are basically insurance contracts on bonds. If the bank were to default before the markets opened on Friday, the effect on the repo and swaps markets would be chaotic. At two o’clock that morning, Geithner called Don Kohn and told him that he wasn’t confident that the fallout from the bankruptcy of Bear Stearns could be contained. At about 4 A.M., Geithner spoke to Bernanke, who agreed that the Fed should intervene. The central bank decided to extend a twenty-eight-day loan to J. P. Morgan, Bear’s clearing bank, which would pass the money on to Bear. In agreeing to make the loan, Bernanke relied on Section 13(3) of the Federal Reserve Act of 1932, which empowered the Fed to extend credit to financial institutions other than banks in “unusual and exigent circumstances.” News of the Fed’s loan got Bear through trading on Friday, but Bernanke and Paulson were eager to find a permanent solution before the Asian markets opened on Sunday night. After a weekend of torturous negotiations, J. P. Morgan agreed to buy Bear Stearns for a knockdown price of two dollars a share, but only after the Fed agreed to take on Bear’s twenty-nine-billion-dollar portfolio of subprime securities. The day the Federal Reserve announced the rescue of Bear Stearns, it also cut the discount rate by another quarter point, and said that for a time it would open the discount window to twenty Wall Street firms—an unprecedented step. Fed officials felt they had little choice but to let investment banks borrow from the Fed on the same terms as commercial banks, even if it encouraged moral hazard. There is now wide agreement that Bernanke and his colleagues made the correct decision about Bear Stearns. If they had allowed the firm to file for bankruptcy, the financial panic that developed this fall would almost certainly have begun six months earlier. Instead, the markets settled for a while. Nevertheless, after Bear Stearns’s deal with J. P. Morgan was announced, Bernanke was attacked—by the media, by conservative economists, even by former Fed officials. Some of the criticisms were unfair. In fact, it quickly became clear that an important precedent had been set: the Bernanke doctrine now included preventing the failure of major financial institutions. Since the collapse of the mortgage-securities market on Wall Street, in the summer of 2007, mortgage securitization had been left mainly in the hands of two companies that operated under government charters to encourage home-ownership: the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Like the Wall Street firms, Fannie and Freddie had suffered big losses on their vast loan portfolios, and many Wall Street analysts believed that the companies were on the verge of insolvency—an alarming prospect for the U.S. government. In order to finance their purchases of mortgages and mortgage bonds, Fannie and Freddie had issued $5.2 trillion in debt, and although they were technically private companies, their debt traded as if the government had guaranteed it. If the companies defaulted, the creditworthiness of the entire government would be called into question. The plan to prop up Freddie and Fannie was no more warmly received than the Bear Stearns rescue package had been. Bernanke couldn’t say so publicly, but he agreed with some of the critics. For years, the Fed had warned that Fannie and Freddie were squeezing out competitors and engaging in risky mortgage-lending practices. Bernanke would have liked to combine a rescue package with extensive reforms, but he realized that an overhaul of the companies was not politically feasible. Despite their financial problems, Fannie and Freddie still had many powerful allies in Congress, and Bernanke was determined that the plan be approved quickly, in order to restore confidence in the markets. WORD STUDY Explore the article and do the following tasks: 1) ''Match the words having similar meanings:'' '' 2) Match the words to produce the proper collocations:'' 3) Provide in-depth, thoughtful answers to the following questions: 1. In what way did Paulson differ from Bernanke? What were their relations? 2. Why did the Fed intervene to rescue Bear Stearns? Was it the right decision? 3. What is “moral hazard”? 4. What is the ‘repo” market? 5. Why was Bernanke so fiercely attacked after bailing out Bear Stearns? 6. Why was it so important for the US government to support such private companies as Freddie Mac and Fannie Mae? 7. Was the Fed`s plan to prop up Freddie Mac and Fannie Mae warmly received by experts? Why? Anatomy of a Meltdown ' Part 4 Abridged' On August 21st, Bernanke departed for the annual Jackson Hole conference, which was to be devoted to the credit crunch. Over the course of three days, one speaker after another challenged aspects of the Fed’s response, and, implicitly, of Bernanke’s leadership. Allan Meltzer, of Carnegie Mellon, complained that the Fed had adopted an ad-hoc approach to bailing out troubled firms. Franklin Allen, a professor at the Wharton School, said that banks and investment firms could use the Fed’s lending facilities as a means of concealing the state of their finances, and Willem Buiter, of the London School of Economics, accused the Fed of doing the financial industry’s bidding, saying that the central bank had “internalized the fears, beliefs, and world views of Wall Street” and fallen victim to “cognitive regulatory capture.” Alan Blinder, Bernanke’s friend and colleague from Princeton, defended him, arguing that the Fed had performed well in trying circumstances, and Martin Feldstein, a Harvard economist, said that it had “responded appropriately this year.” But Feldstein added that the financial crisis was getting worse as housing prices continued to drop and homeowners to default. Perhaps the most suggestive comments were made by Yutaka Yamaguchi, a former deputy governor of the Bank of Japan, who, during the nineties, helped manage Japan’s response to a ruinous speculative bust. The Bank of Japan began cutting interest rates in July, 1991, Yamaguchi recalled, but the financial system didn’t stabilize until after the Japanese government bailed out a number of banks, a project that took almost a decade. The main lesson of the Japanese experience, he said, was the need for an “early and large-scale recapitalization of the financial system,” using public money. Throughout the discussion, Bernanke sat quietly and listened. He looked exhausted, and during one presentation he appeared to fall asleep. In his own speech, he defended the Fed’s actions and argued that in the future the agency should be given more power to supervise big financial firms and opaque markets such as the repo market, and that a legal framework should be established to allow the government to intervene when they got into trouble. The speech suggested that Bernanke had adopted a more favorable view of regulation, but he made no mention of using monetary policy to deflate speculative bubbles or of recapitalizing the banking system. Bernanke still believed that his finger-in-the-dike strategy was working. After all, in the second quarter of the year the Gross Domestic Product had expanded at an annualized rate of almost three per cent—and the unemployment rate was under six per cent. Commodity prices, including oil prices, had started to fall, which would ease inflation pressures. In Washington, over Labor Day weekend, Bernanke and Paulson met to discuss Fannie and Freddie. In the five weeks since Congress had given the Bush Administration broad authority to invest in the companies, the firms had tried unsuccessfully to raise capital on their own. Paulson and Bernanke decided that a government takeover was now the best option. In addition to removing the threat that Fannie and Freddie would default on their debts, it would enable the government to expand their lending activities and help stabilize house prices. On Sunday, September 7th, Paulson announced that the government would place Fannie and Freddie in a “conservatorship,” replacing their chief executives, taking an eighty-per-cent ownership stake in each of the companies, and providing them with access to as much as two hundred billion dollars in capital. The next day, the Dow closed up almost three hundred points. The billionaire Warren Buffett, whom Paulson had briefed on the move, said that it represented “exactly the right decision for the country.” Even the Wall Street Journal’s editorial page, which for months had criticized Paulson and Bernanke, grudgingly endorsed the plan. At the Treasury Department and the Fed, there was little opportunity to celebrate. On Tuesday, September 9th, stock in Lehman Brothers dropped by forty-five per cent, following reports that it had failed to secure billions of dollars in capital from a Korean bank. Lehman approached several potential buyers, including Bank of America and Barclays, the British bank. But by the end of the week it was running out of cash. On Friday evening, Geithner and Paulson summoned a group of senior Wall Street executives to the New York Fed and told them that the government wanted an “industry” solution to Lehman’s problems. Talks continued through the weekend, but by Sunday afternoon both Bank of America and Barclays had bowed out, and word circulated that Lehman was preparing to file for bankruptcy. Remarkably, once the potential bidders dropped out, Bernanke and Paulson never seriously considered mounting a government rescue of Lehman Brothers. Bernanke and other Fed officials say that they lacked the legal authority to save the bank. “There was no mechanism, there was no option, there was no set of rules, there was no funding to allow us to address that situation,” Bernanke said last month, at the Economic Club of New York. However, Bernanke and Paulson were undoubtedly sensitive to the charge, made in the wake of their efforts to salvage Bear Stearns, Fannie Mae, and Freddie Mac, that they were bailing out greedy and irresponsible financiers. For months, the Treasury and the Fed had urged Lehman’s senior executives to raise more capital, which the bank had failed to do. Many analysts remain skeptical that the Fed couldn’t have rescued Lehman. At the time, a popular interpretation of Lehman Brothers’ demise was that Bernanke and Paulson had finally drawn a line in the sand. (“We’ve reestablished ‘moral hazard,’ ” a source involved in the Lehman discussions told the Wall Street Journal.) But less than forty-eight hours later the Fed agreed to extend up to eighty-five billion dollars to A.I.G., a firm that had possibly acted even more irresponsibly. One difference was that the Fed, in charging A.I.G. an interest rate of more than ten per cent and demanding up to eighty per cent of the company’s equity, had been able to impose tough terms in exchange for its support. More important, A.I.G. was a much bigger and more complex firm than Lehman Brothers was. In addition to providing life insurance and homeowners’ policies, it was a major insurer of mortgage bonds and other types of securities. If it had been allowed to default, every big financial firm in the country, and many others abroad, would have been adversely affected. But even the announcement of A.I.G.’s rescue wasn’t enough to calm the markets. On Tuesday, September 16th, the Reserve Primary Fund, a New York-based money-market mutual fund that had bought more than seven hundred million dollars in short-term debt issued by Lehman Brothers, announced that it was suspending redemptions because its net asset value had fallen below a dollar a share. The subprime virus was infecting parts of the financial system that had appeared immune to it—including the most risk-averse institutions. Bernanke accompanied Paulson to Capitol Hill to warn reluctant congressmen about the catastrophic consequences of failing to pass a bailout bill. (“When you listened to him describe it, you gulped,” Senator Chuck Schumer, the New York Democrat, said of Bernanke’s evocation of the crisis. Often, it was clear that Bernanke and Paulson were improvising. On November 10th, the Fed and the Treasury Department announced that they would provide more money to A.I.G., raising the total amount of public funds committed to the company to a hundred and fifty billion dollars. (The Fed’s original eighty-five-billion-dollar loan, and a subsequent one, of $37.8 billion, had proved inadequate.) Two days later, Paulson abandoned the idea of buying up distressed mortgage securities—a proposal that he and Bernanke had vigorously defended—and last week, at a hearing of the House Financial Services Committee, congressmen excoriated him.. The Congressman had a point. Paulson’s and Bernanke’s efforts to prop up the financial system have so far had little effect on the housing slump, which is the source of the trouble. Until that problem is addressed, the financial sector will remain under great stress. Last week, the stock market plunged to its lowest level in eleven years, auto executives flew into Washington on their corporate jets to demand a bailout, and Wall Street analysts warned that the political vacuum between Administrations could create more turmoil. “We can’t get from here to February 1st if the current ‘who’s in charge?’ situation continues,” Robert Barbera, the chief economist at I.T.G., an investment firm, told the Times. Bernanke, though, remains remarkably calm. (Jim Cramer would say oblivious.) He is unapologetic about the alterations to the bailout plan, arguing that changing circumstances demanded them, and he is relieved that the Treasury Department and Congress are now leading the government’s response to the crisis. Despite grim news on unemployment, retail sales, and corporate earnings, he is hopeful that an economic recovery will begin sometime next year. Until the middle of last week, there were signs that the credit crisis was easing: some banks were lending to each other again, the interest rates that they charge each other have come down, and no major financial institution has failed since the passage of the bailout bill. “It was a very important step,” Bernanke told me last week, referring to the bailout. “It greatly diminished the threat of a global financial meltdown. But, as Hank Paulson said publicly, ‘you don’t get much credit for averting a disaster.’ ” On Wall Street, Bernanke’s reviews have improved, especially at firms that have received assistance from the Fed. “I think he has done a superb job, both in coming up with innovative solutions and in coördinating the policy response with the New York Fed, the Treasury Department, and the S.E.C.,” John Mack, of Morgan Stanley, told me. “I give him very high marks.” George Soros, the investor and philanthropist, whose firm has not benefitted from the Fed’s largesse, said, “Early on, being an academic, he didn’t realize the seriousness of the problem. But after the start of the year he got the message and he acted very decisively.” Still, Soros went on, citing renewed turbulence in the markets and speculation about the fate of Citigroup, whose stock price last Friday fell below four dollars, the crisis is far from over. “With Lehman, the system effectively broke down. It is now on life support from the Fed, but it’s really touch and go whether they can hold it together. The pressure is mounting even as we speak.” He added, “We may be on the verge of another collapse.” Bernanke, in a search for inspiration and guidance, has been thinking about two Presidents: Franklin Delano Roosevelt and Abraham Lincoln. From the former he took the notion that what policymakers needed in a crisis was flexibility and resolve. After assuming office, in March, 1933, Roosevelt enacted bold measures aimed at reviving the moribund economy: a banking holiday, deposit insurance, expanded public works, a devaluation of the dollar, price controls, the imposition of production directives on many industries. Some of the measures worked; some may have delayed a rebound. But they gave the American people hope, because they were decisive actions. Bernanke’s knowledge of Lincoln was more limited, but one morning the man who organizes the parking pool in the basement of the Fed’s headquarters had given him a copy of a statement Lincoln made in 1862, after he was criticized by Congress for military blunders during the Civil War: “If I were to try to read, much less answer, all the attacks made on me, this shop might as well be closed for any other business. I do the very best I know how—the very best I can; and I mean to keep doing so until the end. If the end brings me out all right, what is said against me won’t amount to anything. If the end brings me out wrong, ten angels swearing I was right will make no difference.” Bernanke keeps the statement on his desk, so he can refer to it when necessary. ♦ A List of Vocabulary ''' '''Explore the article Part 4 and do the following tasks: 1) Match the words having similar meanings: '' 2) Match the words to produce the proper collocations:'' 3) Provide in-depth, thoughtful answers to the following questions: 1. What accusations were brought against the Fed at the annual Jackson Hole conference? 2. What are the signs of successful implementation of Bernanke`s strategy of a government takeover? 3. Why did the Fed fail to step in to rescue Lehman Brothers, but agreed to extend $85billon to A.I.G.? 4. What does Hank Pauson`s phrase, “you don`t get much credit for averting a disaster” imply? 5. Who inspires and provides guidance for Bernanke? 6. Find in this articles relevant phrases, pertinent collocations, statements charactering Ben Bernanke.